Fed Chair Yellen, delivering testimony to the US Congress, had been expected to stick to her guns with a hawkish policy stance in line with comments made in June in which she seemed to turn a blind eye on weak inflation figures and signalled that policy normalisation would continue. However, she surprised with a more dovish tone, acknowledging that “inflation has been running under (the Fed’s) 2% objective, [and] that there could be more going on there.” As pointed out in the fifth Beige Book – a regional economic survey release by the Fed – wages only increased at a ‘modest to moderate pace.’ Wage pressure is typically a key element on fuelling sustained inflation. The report also highlighted the continued tightening of the job market, especially in the construction and IT sectors, taking the employment rate to close to a 16-year low at 4.4% and leaving the country with a shortage of qualified workers.

Exhibit 1: Core inflation (%YoY)

Inflation targeting still matters… for the Fed

Yellen’s speech contrasted with recent debates (June 2017) at the European central bankers’ forum in Sintra, Portugal. Indeed, ignoring official inflation targets and instead focusing more on rising financial asset prices was one of the main takeaways from the ECB forum. Yellen’s speech has swung the focus back to more traditional concerns about inflation targeting. Alternatively, her dovish tone may have been a precaution to avoid what has been seen as miscommunication by ECB President Draghi, whose hawkish tone had triggered a bond sell-off in Europe. The ECB was later forced to adjust Draghi’s message and smooth its hawkish tone. While Yellen was cautious on inflation, she also reiterated the Fed’s commitment to policy normalisation and to trimming its crisis-era QE-inflated balance sheet starting ‘this year’ (2017).

Exhibit 2: US core consumer price index (%YoY)

Source: BLS, BNP Paribas Asset Management, as of 17/07/2017

US inflation surprises to the downside

Confirming Yellen’s concern, the latest US inflation data disappointed again. Year-on-year core inflation was 1.7% in June 2017, extending the downward trend since the 2.3% peak this February 2017. Except for January 2017, the core inflation surprise index – reflecting the difference between survey data and the official release – has not been positive since August 2016.